Tax-Smart Ways to Sell Your Business
The decision to sell your business is a serious one that can have financial implications for years to come when not done correctly. Poor structuring of the sale can create a large tax bill and reduce the amount of profit you receive. A savvy and well-thought-out plan could help you create a tax strategy that protects your profits and reduces the taxes you could otherwise owe.
Designing the Sale
The way the sales contract is built could be the most important consideration to the seller as this will determine how he or she will be taxed. Often, what is best for the seller is not always best for the buyer. Therefore, it is important to be prepared for some negotiation and compromise.
Instead of valuing the entire sale as one single transaction or cost, the sales contract should separate assets of the business and value them individually. This way, certain parts of the sale of the company can be counted as the sale of assets and be taxed as a capital gain. Capital gains tax rates are much lower than the income tax rate, saving the seller a great deal of taxes on the sale.
For example, if someone is selling an auto service and repair business for $200,000, and the sales contract is drawn to simply say the buyer will pay $200,000 for the business as a whole, it could cause the seller to pay taxes on $200,000 at their regular income tax rate, which could be as much as 37 percent.
However, instead of selling the company as a whole for $200,000, the contract could separate assets owned by the company, such as different pieces of equipment, and place a value on each one. Then the seller would only need to pay capital gains on each asset at only 15 percent.
This is a huge tax-savings strategy for the seller and could reduce the overall taxes on the sale tremendously. It is important to take time to work with a New Jersey tax attorney to identify every possible asset the company owns and valuate it in the contract. This is true for intangible assets as well, such as goodwill. Overlooking an asset can be a costly mistake when selling a business.
One-Time Sale or Installment Sale
If you can afford to accept monthly payments for your business, an installment sales contract may be the ticket. Allowing monthly installment payments for your business means that you don’t have to pay the entire tax bill for selling the business at once. Instead, you are only required to pay taxes on the interest and principal payments you received that year. This is certainly a great way to defer taxes owed.
The downside to installment payments is that you will only receive a certain amount of money each year. This could be fine at the beginning of the contract, but it could be frustrating if your financial circumstances require more income in the future.
In addition, by accepting installment payments for your business, you are running the risk that the buyer will not be able to produce adequate income in the company to continue to make the installment payments.
Recapturing Depreciation
If you have taken depreciation on the assets you are selling with the business, you must recapture it during the sale of the asset. If the depreciation you took is less than the amount you sell it for, the gains on the asset will be taxed as ordinary income. This is a big reason to consider the value of assets when you begin your company. As they say, you have to consider the best way out of your business on the day you start it. Tax planning is always important.
Consider a Stock Sale
If your business is a corporation, a stock sale could be beneficial for you and your stockholders. If stock in the business is sold, the shareholders only have to pay taxes once on the sale of the stock. If not, the corporation will have to pay taxes once, and then its shareholders would have to pay taxes again. Buyers will typically not prefer a stock sale because it limits their ability to depreciate items when they take control of the business.
Selling a business can be incredibly complex, and all the right moves may not be obvious. It could be a good idea to consult a New Jersey tax attorney who could help make sure you are structuring the sale in the most beneficial way. Don’t hesitate to contact us at the Dopkin Law Firm in Cherry Hill by calling (215) 519-4269. We work with New Jersey business sellers to help protect their income and create estate planning with profits from the sale.